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Markets with heterogeneous beliefs: A necessary and sufficient condition for a trader to vanish

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  • Massari, Filippo

Abstract

What does it take to survive in the market? Previous literature has proposed sufficient conditions for a trader to vanish, which depend on pairwise comparisons of traders’ discounted beliefs. We propose a novel condition that focuses on the ratio of traders’ discounted beliefs and (approximate) equilibrium prices. Unlike existing conditions, ours is both necessary and sufficient for a trader to vanish and delivers the exact rate at which vanishing traders lose their consumption shares. As an application, we analyze the performance of two intuitive behavioral strategies: the “Follow the Leader Strategy” that prescribes mimicking the beliefs of the most successful trader, and the “Follow the Market Strategy” that prescribes to use beliefs which coincide with the state price density. Further, we show that the relative performance of vanishing traders cannot be studied in isolation. Our analysis highlights an intuitive point obscured by the existing conditions: trading in financial markets is qualitatively different from bilateral trading.

Suggested Citation

  • Massari, Filippo, 2017. "Markets with heterogeneous beliefs: A necessary and sufficient condition for a trader to vanish," Journal of Economic Dynamics and Control, Elsevier, vol. 78(C), pages 190-205.
    • Handle: RePEc:eee:dyncon:v:78:y:2017:i:c:p:190-205
    DOI: 10.1016/j.jedc.2017.03.008
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    References listed on IDEAS

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    15. Elyès Jouini & Clotilde Napp, 2010. "Unbiased Disagreement in Financial Markets, Waves of Pessimism and the Risk-Return Trade-off," Review of Finance, European Finance Association, vol. 15(3), pages 575-601.
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    19. Roman Muraviev, 2013. "Market selection with learning and catching up with the Joneses," Finance and Stochastics, Springer, vol. 17(2), pages 273-304, April.
    20. repec:dau:papers:123456789/78 is not listed on IDEAS
    21. He, Xue-Zhong & Shi, Lei, 2017. "Index portfolio and welfare analysis under heterogeneous beliefs," Journal of Banking & Finance, Elsevier, vol. 75(C), pages 64-79.
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    Cited by:

    1. Massari, Filippo, 2019. "Market selection in large economies: a matter of luck," Theoretical Economics, Econometric Society, vol. 14(2), May.
    2. Marinacci, Massimo & Massari, Filippo, 2019. "Learning from ambiguous and misspecified models," Journal of Mathematical Economics, Elsevier, vol. 84(C), pages 144-149.
    3. Dindo, Pietro & Massari, Filippo, 2020. "The wisdom of the crowd in dynamic economies," Theoretical Economics, Econometric Society, vol. 15(4), November.
    4. Breitmayer, Bastian & Massari, Filippo & Pelster, Matthias, 2019. "Swarm intelligence? Stock opinions of the crowd and stock returns," International Review of Economics & Finance, Elsevier, vol. 64(C), pages 443-464.
    5. Norman, Thomas W.L., 2020. "Market selection with an endogenous state," Journal of Mathematical Economics, Elsevier, vol. 91(C), pages 51-59.
    6. Bottazzi, Giulio & Giachini, Daniele & Ottaviani, Matteo, 2023. "Market selection and learning under model misspecification," Journal of Economic Dynamics and Control, Elsevier, vol. 156(C).
    7. Dindo, Pietro, 2019. "Survival in speculative markets," Journal of Economic Theory, Elsevier, vol. 181(C), pages 1-43.
    8. Giulio Bottazzi & Pietro Dindo & Daniele Giachini, 2018. "Long-run heterogeneity in an exchange economy with fixed-mix traders," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 66(2), pages 407-447, August.
    9. Daniele Giachini, 2018. "Rationality and Asset Prices under Belief Heterogeneity," LEM Papers Series 2018/07, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    10. Xu, Shaojun, 2023. "Behavioral asset pricing under expected feedback mode," International Review of Financial Analysis, Elsevier, vol. 86(C).
    11. Yu Zhang & Weihong Huang, 2018. "Impact of strategy switching on wealth accumulation," Journal of Evolutionary Economics, Springer, vol. 28(4), pages 961-983, September.
    12. Filippo Massari, 2021. "Price probabilities: a class of Bayesian and non-Bayesian prediction rules," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 72(1), pages 133-166, July.
    13. Jonathan Newton, 2018. "Evolutionary Game Theory: A Renaissance," Games, MDPI, vol. 9(2), pages 1-67, May.

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    More about this item

    Keywords

    Market selection; General equilibrium; Heterogenous beliefs; Asset pricing; Learning;
    All these keywords.

    JEL classification:

    • D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • G1 - Financial Economics - - General Financial Markets

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